Rule 3: Reasonable Expectations

Stories of super successful investors such as Buffet, Carnegie, Soros, and many others are all over the place.  The wisdom of these gurus is often quoted as gospel, and it is difficult to argue with their success.

The average investor wants to emulate the success of these people.  This creates unreasonable expectations and what I call 'stupid greed.'  We need 'smart greed!'

Take a look at any legendary investor's story.  Be careful to read between the lines.  All of them, at least the ones I am familiar with, have some edge or other that the average investor lacks.  None of them got lucky, and all of them worked very hard for their success.  Often times whatever edge they had is not available to the average person.  For example some of Carnegie's methods of success would be illegal today.  Other investors such as Lynch are their generation's geniuses, who were able to see opportunities missed by their peers and achieved success far above the average investor.  

As average investors we likely do not have an edge that makes us better than everyone else.  We can't expect to play chess like Fischer or box like Pep.

While we can not be the next Graham, we can avoid making stupid investment decisions.  Achieving average returns is far better than holding the bag the next time the bubble bursts.

Stupid greed can presently be seen in the crypto currency markets.  Latecomers want to see the extraordinary returns enjoyed by early adopters, those few nerds that turned $100 or some spare processing power in to hundreds of millions.  As such many are pouring money into dubious alt coins hoping to get rich.  They are not performing due diligence because if they were, most alt coins would be worthless (there are lots of good alts, but a multitude of bad ones).  

I told a friend to buy bitcoin at $1000, $3000, and $7000.  Each time this person was adamant that such a price was far too much to pay for one.  And yet today, only a month or two after the 7k suggestion, bitcoin is trading at $16,000.  This person didn't want to double their money, they wanted to win the lottery.  They told me to notify them when I found an alt coin that was going to ascend to the heavens.  I am not very good at picking alts, but each time I suggested bitcoin I predicted a price increase.  Instead of easy money this person got nothing.

No one would expect to buy amazon stock today and see the returns that late 90's investors earned.  From about $2 a share to over 1k, these are gains that early bitcoin enthusiasts are currently realizing.  But hardly anyone gets these kinds of returns because it is hard to identify these kinds of opportunities.

It is easy to become excited about an investment.  It is extremely difficult to correctly identify the best opportunities.  My most recent mistake was losing money on bitcoin mining contracts.  I did not consider all of the variables and ended up losing about 50% of my investment when network difficulty increased much faster than I had anticipated.  I hope to write more about this experience in the future because it was an excellent, and expensive, learning experience.

Smart greed means finding a smart edge.  We don't need to beat everyone else's returns or get rich in a few weeks.  For example simply following Lynch's suggestion of regular contributions to an index fund is really easy to follow and will vastly increase wealth long term.  This is a strategy based on solid evidence: even if one started contributing at market peaks, one would be far better off over a period of 10 years compared to holding cash.  We don't need to stress about political events or market crashes using this strategy.  Simply set regular contributions, go about our lives, and check back in a decade or two.  Easy!

We don't need to be geniuses.  We just need to be smart and have reasonable expectations.  If an investment seems like a good idea, it needs to be provable.  Had I done more thorough calculations for my mining investment I would have quickly seen that a small deviation would result in a loss.  I got excited about making money, and I got stupid.  Sagan famously said that extraordinary claims require extraordinary proof.  By the same token, the more one wants to earn from investments, the more one must work to prove that any given opportunity is exceptional.

Rule 2: Find The Red Flags First

I have a loose set of rules that I always try to keep in mind while evaluating investments.  This is an easy one!  Rule 2 is that I always look for red flags first.  Why spend countless hours of research when I can find problems with an investment right away and save myself the time?

For example, a while back a friend wanted my opinion about a company named Mcig.  They make vaporizers for marijuana and the idea was to cash in on legalization in Colorado as well as upcoming legislation in other places.  It took maybe 15 minutes for me to decide that I didn't like the company.  A brief look at their balance sheet revealed 80-90% of their assets listed as goodwill.  In a nutshell goodwill is anything intangible such as a brand name.  These things may have incredible value in some cases, but a company with pretty much all of their value listed as goodwill seems unusual.

Next, even though I already didn't like the company, I looked up some product reviews.  Although they didn't have a ton of reviews on retailer websites, a quick search showed that the average customer was either not impressed or disliked the product.

They are still in business so maybe Mcig will become a killer.  However at the time I did not see any reason to invest.  I don't remember the exact date but it was in 2014 or so.  It had caught my friend's attention because the price had shot up recently.  There didn't seem to be anything special about the company.  Why waste the time to contact investor relations and do all the other things needed before an investment can be properly evaluated?  The current price is still below the 2014 spike.  It might go up, it might not, I have no idea.  But I do know that there are better investments out there.  I can't predict the future but I can say that at the time there were other manufacturers of vaporizers that looked much more attractive.

There are so many opportunities out there.  One way to success is spending more time finding them and less time on companies easily eliminated from consideration.

Rule 1: There Are No Missed Opportunities

I have a loose set of rules that I use to guide my investment strategies.  First and foremost is the idea that I should not worry about missed opportunities.

Many people I have spoken with regret not buying this or that sooner because they would be rich had they done so.  This is more or less the idea of opportunity cost.  While this may be useful in an academic setting, it is disastrous for me as an investor.  The fact is that no matter what choice I make, there is nearly always a better one.  I don't waste energy stressing about this kind of thing.

I don't worry about opportunities that I missed. I take as much time as needed to find and vet an investment. If it takes two weeks to read all of the annual reports, find the scuttlebutt, and get the information I need, then that is how long I spend.  If the price changes in that time and makes the investment less attractive, I simply move along.  There is a great investment opportunity every day of the week, I just have to find it.  For example NYSE: PPDF, whatever that is, went up 15% today.  I had no way to predict this so I won't feel bad about missing it.  So many people stress about selling too soon or not buying sooner.

Predicting the future is impossible.  Obviously we would all be filthy stinking rich if it was.  My perspective is that I make the best decision I can based on the information I have.  Usually I make money, sometimes I don't.  But I never second guess my decisions.  I learn from them.  Otherwise I will never have any level of confidence in investment choices.  In stead I would watch the ticker all day and agonize every time the price moves against me.  Occasional swing opportunities aside, I invest for the long term.  I don't care what the price is doing today, I care if the company or other asset is performing as expected.  If yes I hold, if no I sell.

When GE announced the Alstrom deal, and I had time to look at the details, I sold.  It didn't matter that I only made a measly 2%.  What mattered was the deal clearly stank and further revealed poor company leadership.  The price of GE went up at some point after I sold, but that is irrelevant.  What mattered to me was the fact that GE's business was getting worse not better.  So I sold and never looked back.  Except the other day when I saw a news article about GE's decline which cited the Alstrom deal as one of the factors leading to the company's current situation.  Immelt is leaving (and made out like a bandit) so things may improve.  Note to the GE board: I guarantee, 100%, that I can do at least as good of a job running shareholder value in to the ground as Immelt did.  I will even do it for a few million less! 

Another example: I previously owned shares in a company called Windstream (WIN). They were not a rock solid company, but they had a tremendous dividend of around 12% when I bought them.  One day I noticed the stock price had shot up something like 30%.  It turns out that the company spun off its physical assets (phone lines and such) in to a REIT which was held by the parent company.  I wanted to sell right away but I didn't understand the details of the restructure.  After reading for a few hours I came to the conclusion that the new structure was just a sneaky way to lower the dividend without spooking investors.  When I sold the massive gain following the REIT announcement had dropped down to something like 15%.

I don't regret waiting to sell, and I don't consider the extra 15% to be lost money.  I didn't know anything about REITs at the time or the details of the restructure.  There was a very real possibility that it would lead to better performance for WIN in some way.  Turns out selling was a good move; the stock has dropped quite a lot since then.  But making decisions on information is better than simply reacting, even if it does cost me 15% once in a while.  Had the restructure made any sort of sense I would have likely held and ignored short term fluctuations.

Second guessing every decision only leads to stress and emotional investing.  It is best avoided at all costs.